The Calm Before the (Potential) Storm

Tomorrow with the release of the CPI at 8:30 am CST we could see a breakout of the 10 year treasury yield. To us a breakout will be a close for the day above 2.90% and of course only a stones throw from the 3% mark.

The expected range on the CPI is 1.9% to 2.3% and we can expect this breakout to occur if the reported rate is above the top end of consensus.

Investors need to once again be positioned correctly–we know we sound like a broken record.  “Correctly” means understanding the loss of capital that comes with higher rates and perpetual securities.

Of course if investors want to change positioning there are just 35 minutes left to do it prior to the CPI release.

On the other hand maybe the number tomorrow will be soft in which case the 10 year treasury will temporarily fall back to the 2.80% level.

Ouch – Spark Energy F-to-F Tumbles

While we own only 2 perpetual preferreds personally and 1 is a fixed-to-floating rate issue there is still pain from time to time.

1 of our holdings had a big seller– Spark Energy 8.75% fixed-to-floating perpetual just dropped by a buck.

Guess they wanted out pretty bad.  Given that the shares represent 1% of our holdings for us there is modest pain, but it does show what can happen to these high yield issues with thin trading.

While we don’t build our personal portfolios with a bunch of high yield issues (quite the contrary) if you look at the partially invested High Yield Portfolio you can see that a hit like the above mentioned can take a chunk quickly.

New Purchase Made in the High Yield Portfolio

We have added a full position to the Enhanced High Yield Income Portfolio of the 8.625% Resource Capital Fixed-to-Floating rate preferred (NYSE:RSO-C).

This purchase brings this particular model up to 43% invested so we will need another 4-5 issues to finish up construction of this model.

Here are the reasons we have purchased this security for this model.

  1. The issue is fixed-to-floating rate meaning at a point 6 years in the future there is interest rate risk coverage.
  2. The issue is from a commercial mortgage REIT which helps diversify the energy heavy preferreds bought previously.
  3. Resource Capital has recently (15 months ago) drafted a plan to divest residential mortgage businesses as well as non core businesses and has executed the plan leaving them with substantial cash on hand.  Impaired assets were sold or marked to market and are for sale.
  4. The commercial real estate portfolio RSO owns is primarily senior floating rate loans.
  5. RSO was able to issue a convertible note at 4.50% while paying off convertible notes with coupons of 6 and 8%.

While we believe this issue, like all perpetuals, is susceptible to loss of capital as interest rates increase, we are willing to incur that risk to own a high yield security. Reasonable higher yield preferreds are in somewhat short supply, but given the improvements in performance coming from RSO we think this issue fits right in.

Midday Report

After hitting near 2.90% overnight the 10 year treasury has settled in to a trading range of 2.84-2.87%.  We are assuming that investors are awaiting the CPI release on Wednesday before trying to drive rates over 2.90% on the way to 3%.  It must be remembered that once rates are stable it takes a few days before investors are willing to tip toe back in–if we get a Goldilocks CPI report we would expect rates to be stable for another week and maybe we will gain a 1/2% in average capital gain on issues we own.  Of course we have only lost 3/4-1% on most the the issues so it is unlikely we can have significant bounces.

With interest rates remaining under control the average preferred/baby bond is up 1 cent–with most issues up or down 10 cents or less.  There are a few larger movers.  Colony Northstar (CLNS) has 3 issues moving 2-3% higher as they had been too severely punished for a decent REIT with high coupon preferreds.  CLNS, like Ashford Hospitality (AHT) is simply an unloved issue.

Of course everyone knows that equity prices are way up with the DJIA up another 400 points–a bit of irrational exuburance for the day.

REITs are down almost a percent again.  The retail related issues we are watching closely are mostly flat.  KIMCO (KIM) is flat at this moment at $14.19 after being as low as $13.75–current yield is 7.90%.  Realty Income (O), the cause of continuous fighting over on Seeking Alpha, is down 46 cents trading at $48.44 giving a current yield of 5.25%–a point at which we normally would be interested, but not this time.  Tanger Outlets (SKT) is just barely positive at $22.88 for a current yield of 5.99%.  Whitestone REIT  (WSR) sold off early today (must be because we just bought shares last week) going as low as $11.75 before recovering to now be at $12.11.  The sell off was caused by an investor presentation released by the company which can be found here.  We skimmed the presentation and didn’t find anything worthy of a selloff in it–but there are enough investors willing to try to read between the lines which means there are sellers based on nothing at all many times.

Utilities are flattish and MLPs are up a percent or two based on higher energy prices.


Monday Morning Kickoff

So another week is gone and for many investors it was an exciting time and obviously for many it was a panic time.

Interest rates traded in a fairly wide range as the movements in the stock markets drove rates down to 2.75% for part of a day (a flight to safety), but by and large rates (10 year) moved in the 2.82% to 2.89% area. We would expect pressure on rates to continue with the lower end being 2.80% and the upper end being 2.90%–for now at least as we await further economic data.

On the economic data front the most important number coming out next week will be the release of the CPI (consumer price index) on Wednesday, February 14. Year over year change is estimated at 2% with a range of predictions of 1.9% to 2.3%. Given that the FED is focused on inflation any deviations outside of this range could move markets–in particular in the interest rate complex.

After a big week of run-off of the FED balance sheet a week ago the FED actually increased the size of the balance sheet in the last week by $1-2 billion–more or less a rounding error. A week ago we wrote on what we think the outcomes of ‘quantitative tightened’ will be and it isn’t good if the FED goes down that path without adjustment on the way. The bottom line is they can run-off assets on the balance sheet or they can raise interest rates–but not both.  We shall see.

Preferreds took a bit of a hit of 6 cents on the average share (of course averages don’t tell the whole story).  We were disappointed that even the short maturity term preferreds and baby bonds moved a bit lower as the ‘spillover’ from the constant equity poundings finally drug them a bit lower.  We opined this may be coming as it always does when there are multiple day downdrafts in equities.  Of course we have been in a ‘Goldilocks’ market so long our expectations are likely a bit high.

We have 223 issues trading under $25 compared to 219 last week so with the minor price pressure and the modest change week to week in issues under $25 we may be moving to a more stable period.  If interest rates stay in our expected 2.8 to 2.9% during the coming week we may see a modest bump up in prices this week.

A few new issues traded through their 1st full week such as Fidus Investment (NASDAQ:FDUSL)5.875% baby bonds trading at $25.05 while the Jernigan Capital (NYSE:JCAP-B) 7% perpetual preferred fell a buck on Friday to trade around $23.

Sotherly Hotels (NASDAQ:SOHO) announced a new baby bond issue with a very short maturity of 3 years and a pretty decent coupon of 7.25%. A quick review of SOHO’s financials show a reasonably strong, yet small, lodging REIT. This issue is high on our list to purchase this week, both in model portfolios as well as personal portfolios.

In addition to the Sotherly baby bonds we are looking for 2 issues for the  high yield income portfolio which should get that portfolio oever 50% invested–additionally we may add some of the KIMCO common shares (NYSE:KIM) simply because we believe there is some decent capital gains that may occur with KIMCO, but we would rather miss a purchasing opportunity than to buy it too early.  For us a $14/share price (or slightly under) would be a good purchase price.

Tonight (1 am CST) the DJIA is up 175 points on the futures while the 10 year treasury is trading with a higher yield in the 2.89% area.  Hopefully we will see the 10 year treasury trade down in yield during the course of Monday as we think the next potential breach of the 2.90% area will be with the release of the CPI on Wednesday.

Good luck to all as we likely enter another exciting week.

Adding Color to the Medium Duration Income Portfolio

Expanding on our earlier announcement on the new Medium Duration Income Portfolio.

We know from history and logic that bonds and term preferred stocks are more stable in price as there is a ‘date certain’ for redemption or maturity–the longer the date in the future the  redemption/maturity date is the more volatile the share price will be as interest rates move.  This means that even if interest rates rise the share price reaction will be just a tiny fraction of the movement in a similar coupon issue of a perpetual preferred which has no state maturity and may well be outstanding for decades and decades.  If the price is way above $25 or way below $25 as the redemption/maturity date approaches the share price will move closer and closer to $25.

In the past we have composed portfolios of the above types of securities and they have performed very well.  They have paid a reasonably good income stream while maintaining relatively level share prices–this helps us sleep very well at night.  We currently maintain 2 portfolios similar to these on the website.  The longest running portfolio we have constructed in this manner can be found here and has returned about 6.5% annually.

Now it should be obvious that the investor will not ‘get rich’ owning a similar portfolio and that is not the point of the portfolio.  The point is a reasonable return with low volatility which allows a retired person to sleep well at night.

A key to the portfolio is that the general economy remain fairly strong–not in recession.  The issues in the model are NOT investment grade and thus you have to watch the issuer of these securities to make sure financials are NOT going ‘south’ on a sustained basis.  A weak quarter or two is generally not a large concern, but a steady 6 quarter slide would be a cause for concern.

A few words on the starting issues.

Gladstone Capital–a BDC (business development company) has generally performed well.  Being a BDC which is also a closed end fund they are required to have asset coverage of 200% or more which adds a level of safety.

Eagle Point Credit–a specialty finance company which owns a portfolio of CLO’s (collateralized loan obligations) which has performed very well in recent quarters.  While we are not fans of CLO’s and similar instruments ECC is a closed end fund and subject to the 200% asset coverage requirements.

RiverNorth Marketplace–is a non traded mutual fund which owns a portfolio of loans secured from peer-to-peer lending sites.  We are not huge fans of peer to peer lending as the credit risk seems to be higher from our personal experience.  Given the short maturity of the term preferreds we believe shares will perform just fine in spite of what we believe will be marginal performance of their loan portfolio.

To expand further on peer-to-peer sites (ie Prosper).  Originally borrowers would ‘apply’ for loans and ‘lenders’ (you and I) would bid on the loans.  Initially the credit quality was highly suspect  and we didn’t believe the sites were doing a very good screening job on the ‘borrowers’.  After poor performance the sites tightened credit screening and loan performance improved.  Then a few years ago ‘bulk buyers’ of loans came into the market place which changed how these sites operate.  Instead of bidding for loans the bulk buyers are allowed to short circuit the bidding process and instantly do the loan. This means (in our opinion) that the bulk buyers are allowed to buy the best loans–by best we mean the highest credit quality with extremely solid credit histories.  We have not checked RiverNorth portfolio in extreme detail, but we are guessing the quality of loans is better than what we have personally experienced.

Personally we had invested thousands of dollars into loans when Prosper initially launched the site.  Because of issues with their credit screening we experienced losses of 8% for the first couple of years.  After improvement our returns went higher and now are at 4.86% annually since inception.  This was more a trial of the site than a search for yield and we have now been reducing our holdings (as the loans mature we have withdrawn) and are down to around $500 now.

Arbor Realty Trust–a commercial mortgage REIT with good financial performance in the last couple of years.

Sotherly Hotels–a small lodging REIT that has had decent FFO (funds from operations) recently

We think investors in these term preferreds and baby bonds need to at a minimum pay attention to the quarterly earnings reports to ensure resources are adequate to fund dividends and interest payments–BUT if the economy softens subtantially investors have to use more intuitive feelings to determine whether to buy or sell these securities.



Added Medium Duration Income Portfolio

We have started the Medium Duration Income Portfolio which can be found here.

We will add some color to this model during the course of today.  Populating this model is easier than other portfolios as many of the issues that will be in the model are issues we personally own and thus are familiar with them.

Nate that we have the new Sotherly hotel baby bond in the model, although it is not yet trading we will be adding the issue when it does start trading.

The idea of this model is that we reduce volatility and risk by owning only issues that will mature in the next 2-5 years.  Additionally we maintain a pretty fair income stream, lower than perpetual preferreds, but higher than the 10 year treasury or CDs.

Sotherly Hotels Prices Baby Bonds

4:30 PM CST

Sotherly Hotels (NASDAQ:SOHO) has priced their new baby bond issue with a coupon of 7.25%.

Additionally in this case if the company decides to redeem the debt after 2/15/2019 and prior to maturity they will pay a premium of 101%, plus accrued interest

While we are not fond of lodging REITs this issue has some possibilities as it has a maturity date in 2021.  The combination of a 7.25% coupon with the very short maturity date means we need to strongly consider a purchase of this security.

The pricing term sheet for this issue can be found here.

The issue will trade under the ticker SOHOK.  This issue will not trade OTC grey market prior to issuance.  The issue should trade in the next couple of days–watch your broker for the loading of the ticker into their quote system.

We will post when we see the issue start to trade.

Mid Day Report

12:15 pm CST

Well we have an orderly pounding of stocks going on with the DJIA down 600 as I write.  To look at the bright side of things the drop in stocks is supporting lower interest rates as the 10 year is off a few basis points from this mornings high.  I guess it is at this time we are happy we are not common stock holders–off course we have endured the pain of watching common stocks fly higher the last few years as we have had to be happy with our 7% coupon issues.

In spite of interest rates falling a bit midday preferreds, baby bonds and other interest rate sensitive securities are falling by a dime.  This is simply the weak hands tossing the baby out with the bath water.  Most seasoned income investors will ignore this ‘noise’ at this point in time.  Falling by a dime is not meaningful.

REITs are hanging tough and are flat on the day–given the hammering they have received in recent months being flat is a victory.

Utilities remain at a point just above their 52 week lows.  We recently updated the dividends for utilities on the site and as we updated we noted what low current yields most issues still had given the share price depreciation lately.  We aren’t going to incur the market risk for just a 3% dividend.

MLPs are off more than 1% today, but these are not too sensitive to interest rate wiggles, but crude oil is off a buck and this is what is driving MLPs.  We note that the Alerian MLP ETF (NYSE:AMLP) is now at a current yield of about 7.5%.  We may have an interest in a small position if it becomes slightly more attractive.

We could have a very interesting end to the market day today–way up (from current lower levels) or maybe a plunge of a few hundred more Dow points.

We didn’t get our 2nd portfolio launched yesterday as we hoped – simply a case of running out of time.

Interest Rates Remain Elevated

Watching the 10 year treasury today I think it should be obvious to all observers that rates will remain above 2.80% for the foreseeable future. With the 10 year at 2.88% at this moment, after being as high as 2.89%, we think that rates will stay in a 2.80% to 3% range for the the next few weeks. The 10 year will only fall below 2.80% if there is another broad equity market selloff which sparks a flight to safety.

The jobless claims number this morning at 221,000 certainly helps to put a floor under interest rates and until we see some ‘softer’ economic numbers you should expect higher rates and thus lower prices on perpetual preferreds.

We will see how much runoff the FED allowed in the last week at 4 pm today as they release the balance sheet info. As we wrote early in the week we think this is a critical piece of data relative to putting a floor under interest rates–reduced demand at a time of larger supply.

Long dated perpetuals and bonds are off in price today which is expected, but key to us personally is that they move lower in an orderly fashion so as not to spook investors which would cause a panic rush out the doors.

Nustar Reduces Distribution, Announces Merger and Announces Earnings

Nustar Energy (NS), of which we just purchased debt, has announced a merger with their general partner.  Additionally they reduced their distribution from $1.095/unit to 60 cents/unit.  Lastly they announced fairly soft earnings–a small loss.  Actually earnings are an improvement on earnings from the year ago quarter.

We don’t believe any of these items should have a material affect on the baby bonds we bought yesterday, although there could be a ‘knee jerk’ reaction lower.

We need to study there items closer to see if there is a material affect on our holdings.  We will try to get this done in the next day or so.

New Security Added to High Yield Portfolio

8:15 pm CST

As we had mentioned earlier today we planned to add a new issue to the Enhanced High Yield Fixed Income Portfolio today and we have done so.

We have added a full position of —

NuStar Logistics 7.625% Fixed-to-Floating Rate Subordinated Notes (NYSE:NSS) to the portfolio.  We paid $25.45/share (or bond) for it.

This security is the 1st we have ever owned which is in the floating rate period.  The issue was originally sold on 1/15/2013 and became floating rate on 1/15/2018.  The coupon had been fixed at 7.625% until now.

The issue currently has begun floating at a rate of 673.4 basis points plus 3 month libor.  3 month libor is currently trading around 1.79% so the current rate of interest on this issue is 8.51%.

Caution—THIS ISSUE IS CURRENTLY CALLABLE BY NUSTAR. The issue became callable on 1/15/2018 and we had expected the company to call the issue and refinance it with a lower coupon issue. It has not happened–yet.  The company will be announcing earnings tomorrow (2/8) and they could take the opportunity to call this debt at that time (although the issue is over $400 million in size)

The issue is now “accruing” interest and if it remains uncalled until the end of March the interest paid will cover the “call risk” we are incurring by paying $25.45/share for this issue today.  This is a risk we are willing to take at this time to hopefully be able to hold this issue for the foreseeable future.  We are well aware that there are investors that will not pay over $25, but generally we don’t mind having 20 or 30 cents a share of call risk–we have done it for years and it generally works quite well.

NuStar Logistics is a wholly owned subsidiary of master limited partnership NuStar Energy LP (NYSE:NS).  NS has been under some pressure in recent years as energy prices fell as did the companies revenues and profits.  In spite of some difficulties NS continues to pay a $4.38 distribution to common unit holders.  Additionally the company has 3 high yield perpetual preferred issues outstanding with coupons of 9%, 8.50% and 7.625% and with assets of over $6 billion we expect they will be around for a long time to come.  Net income while lower was over $120 million for the 1st 9 months of 2017.

While we could have chosen one of the companies high yield preferreds we believe this one is best because it is higher up the capital stack, plus since there is a chance it could be called there is a high likelihood that it will trade in a tight $24.75 to $25.50 price range lending some stability to the portfolio.  Additionally while it doesn’t have a maturity date until 2043 and long dated maturity date is better than a perpetual stock in particular when you couple the “date certain” maturity with the floating rate feature.

Disclosure–we have owned this security for the last year or so.

Midday Report

Noon CDT

The 10 year treasury has now moved back up by 4 basis points to trade around 2.81% or so and in spite of this preferreds and baby bonds are up 5-8 cents/share as investors continue to search for the right level of pricing.

The Ashford Hospitality group of preferreds are up by 2%, while many of the Gabelli CEF preferreds are down by 2%.

Just watching the trading in the various preferred issues you can see that investors are trying to “position” themselves for whatever they believe is the future of interest rates.

Stocks have been in a wide range today and currently the DJIA is up 200 points. Who knows if the Dow will end up finishing higher or lower, but markets are calm.

In general the issues we own are flattish, except one that went ex-dividend today (Golar LNG Partners 8.75% preferred) by a fat 63 cents.  The 3 initial positions in the High Yield Income Portfolio are all higher.

Put your seatbelts on for the afternoon–most certainly we will have lots of activity–we just hope it remains in an orderly fashion.

Heading into Humpday with Optimism

Such a wild day on Tuesday, but the turnaround in equities we expected Monday finally came yesterday.  It is not that we care too much about what common stocks do performance wise, but there is a spillover affect that can occur and in fact did occur Tuesday.  With the 10 year treasury falling by a good amount preferred stocks stabilized, but did not rise.  A normal expectation would be for income securities to turn higher as the 10 year fell, but we could see all day that “weak hands” were still selling preferreds in spite of the interest rate fall.  Quite simply we still had income investors that were trying to get out of the marketplace in an expedited way.  How unfortunate that they are out–they won’t be back for years and they will bury their money in the back yard and bitch about the crooks on wall street.  Oh well.

Overnight markets around the globe were relatively well behaved.  The U.S. futures market shows the DJIA off a modest amount and the 10 year treasury is trading around 2.80%.  While we don’t expect volatility to go away we do expect markets to trade in a more orderly fashion.

Today (Wednesday) we are looking for a purchase in the Enhanced High Yield Income Portfolio to help get that model invested.  We have our eye on a number of potential issues to buy and we will write more later today as to why we are buying what we are buying.

Additionally today/tonight we will launch the 2nd model portfolio.  We will begin the Medium Duration Income Portfolio.  This will contain primarily term preferreds and baby bonds with maturities in the next 7 years.  This model will be how we personally invest at this point in time.  The idea is to receive a reasonable income stream, with lower risk to net asset value.  Issues in the model will mature relatively soon and interest rates in general may be (who knows for sure) much higher allowing for reinvestment at higher coupons.

In the next few days we will begin to do a weekly highlighted security.  We will be starting with our personal favorites–ones we currently own.  This will continue every week on the same day and will be more in depth than we normally write so it can be used by some newer income investors to understand our logic and methodology more clearly.


Global Markets Rocked While Interest Rates Drop

It looks like we will begin the day with another stock market drop in the U.S. On a historical basis when stocks have dropped interest rates have fallen as folks move to ‘safe haven’ assets. This had not happened in the last few days, but today it looks like rates will drop by a fair amount as the 10 year treasury is trading at 2.73% after closing yesterday around 2.82%.

At this time we are not overly concerned with market movements–not just because we have mostly escaped damage, but because while these large point drops make headlines the movements are not overly crazy–remember we have had so many days in the last year with rises of 200 or 300 Dow points. The bigger damage is done to investors who are somewhat new to investing–each time we have market moves like this it takes years to get these folks back in the market after they are spooked and choose instead to move to cash for no return–a lot it can be blamed on the sensational headlines the media puts out.

It will be interesting to see how income securities react to the interest rate drop. Will they bounce a little? Or will the equity downdraft cause a “throw the baby out with the bath water” reaction with even preferred stocks and baby bonds falling off?

We shall watch closely with interest today as we have for almost 50 years now. The markets never fail to ‘entertain’ us and contrary to the know-it-alls on the TV we find there are always things to learn.

Expanded Discussion on Whitestone REIT

As noted a few hours ago we took a small portfolio position (300 shares) in Whitestone REIT (NYSE:WSR) in the Enhanced High Yield Income Portfolio.  This is a very small position that may be expanded if the share price should drop much further.

As a REIT with a current yield of 9.5% after the drop in share price today this issue certainly meets a need of paying a high current yield.

This new position is partially brought about by our familiarity with WSR as we have owned shares in the company off and on a number of times since they came public just over 10 years ago.

The company is technically a shopping center REIT, but we look at them a bit differently as they lean toward leasing to a large variety of smaller tenants versus a much smaller number of large, more big box types of tenants.  Certainly they have large tenants such as Safeway, Whole Foods, Walgreens and Kroger as tenants, but the largest tenant accounts for just 2.6% of revenue.  They are much more focused on having CPAs, lawyers and fitness centers in small spaces.

WSR is almost entirely focused on Phoenix and various areas in Texas with one property located in the Chicago area.  With the exception of the Chicago area they are in high growth areas which typically have high household incomes and seem to be perfect communities for the concept WSR presents (they call their centers “Community Centers”–not shopping centers)

The company pays a 9.5 cent monthly distribution which they are not currently covering.  Over the years they have at times covered the distribution and other times where they have fallen a few pennies short.  This is the key reason the share price has traded in a range of $10-$15/share their entire existence as they have not ever raised the distribution since going public and they continually either barely cover the distribution or don’t fully cover the distribution.  With WSR I don’t think you can count on share price growth and instead must be happy with the tasty distribution.  In this case we would be more than satisfied with a flat share price.

With the stock market sell off today we are not certain what to expect tomorrow, but we have been through many similar times in the markets in recent years and we have always survived quite nicely and we think this purchase will help us through the year.

Partial Position Purchase In Whitestone REIT Made End of Day

We made a small partial position trade of 300 shares in Whitestone REIT (NYSE:WSR) right at the end of the day at $12.04/share.  This purchase is for the Enhance High Yield Model Portfolio which can be found here.

We had noted earlier just a couple of hours today that we almost bought WSR earlier today–instead we purchased it 60 cents/share below the earlier price.  While we could see more downside in this security we would likely buy more at lower levels.

We will write more later today on this purchase.

To disclose we made the same purchase in our personal accounts.

Income Issues Stabalize–Equities Not So Much

12:50 PM CST

It is nice to see a pause in interest rate (10 year treasury) moves today even though it moved up to 2.88% overnight it has now settled down to the 2.82% area.

Bonds and Preferred stocks are flat to even up a tiny amount.  REITs which started the day off strong are now off by 1 1/2%.  We were so close to buying Whitestone REIT (NYSE:WSR), but fortunately managed to avoid acting too quickly which was good fortune as shares are down 24 cents–just goes to show there is no hurry to pick up some of the high yield issues.

I thought we had the stabilization correct on stocks as shares were very weak on the open, but by mid morning the DJIA was back flat.  Alas that didn’t hold and shares are off 400 right now.

As we review personal and model portfolios we don’t see anything too alarming–short maturities and term preferreds are hanging right in there.

Fidus Investment Baby Bond Commences Trading

BDC Fidus Investment sold a baby bond  last week and the issue has commenced trading today and is trading a tiny bit higher than we thought it would trade given the recent interest rate moves.

Shares are trading in the $24.85 to $25.10 range–about a quarter above where we were thinking it would trade. The coupon is just 5.875%, but the short maturity in 2023 is likely lending support to the price.

With a fall in price that would raise the current yield we would have interest in the 6.25% area.

Lodging REIT Sotherly Hotels to Issue Baby Bonds

Lodging REIT Sotherly Hotels (NYSE:SOHO) will be issuing some baby bonds in $25/shares.

These bonds will be maturing in 2021–so a nice short maturity.  It is quite unusual for a REIT to be issuing baby bonds with a maturity this short.

We will want to do some research on the company prior to the pricing of this issue as we likely will have some interest in a bond with a maturity this short assuming they have a reasonable coupon.

The preliminary prospectus is here.

The pricing and final terms have not been announced and we will publish when this occurs.

Monday Morning Kickoff

Wow!! What a week it was in not only interest rate markets, but obviously in the equity markets.

The 10 year treasury opened the week in the 2.70% area and moved steadily higher all week until closing at 2.85%. Overall not a huge move, but the nervous Nellies dumped stocks and bonds helter skelter. The GDP report and the employment report both had wage inflation components that were running “hotter” than expected.

In addition to the higher wages in the various reports the FED finally got the balance sheet “runoff” underway in noticeable volumes as they let $20 billion of maturities move to cash (or maybe it is just vapor since they created dollars to buy the securities originally). Regardless it is not being reinvested. We have heard some analysts comment that there will be plenty of demand to make up for the “runoff”—we have to call BS on that thinking. The runoff started at $10 billion/month and is to move $10 billion/month higher each quarter so now we are starting the 2nd quarter and the runoff is scheduled to be $20 billion/month until April when it will move to $30 billion/month.  By the end of the year the runoff is supposed to be $50 billion/month.  If there is a belief that the Fed can runoff $50 billion a month, while the treasury runs deficits of $65 billion/month AND the European Union cuts their QE to nothing from $30 billion/month someone should wake up.  NOT GOING TO HAPPEN.  The Fed can raise rates OR they can run off the balance sheet, but later in the year they will not be able to do both unless they are dead set on a recession (this is our prediction).

Last week we only had one new issue being sold and it is yet to trade, although we see that eTrade has it set up in their database so we should see trading begin Monday or Tuesday.

Fidus Investment (NASDAQ:FDUS) sold a baby bond issue of 5.875% notes with a maturity date of 2/1/2023.  The issue is a relatively small one with 1,700,000 $25 shares being sold.  Fidus is a small BDC (business development company) with solid financials and while we like the company we would only be a buyer with a current yield of at least 6.25%-6.50%. The issue is not yet trading, but when it opens up I would think it likely it will NOT trade above $25 anytime soon since rates have popped since the announcement.  The attraction here would be the relatively short maturity date.  We shall see how this develops.

New issues sold the previous week, which are now trading on the NYSE, were Jernigan Capital (NYSE:JCAP) 7% cumulative redeemable preferred and while down it was not bad–

The Costamare Inc. (NYSE:CMRE) new 8.875% preferred issue held up very well which demonstrates the resiliency of the high yield issues.

The average $25/share preferred stock issue fell by a relatively massive 49 cents/share to close at $24.96.  It has been a long time since we have seen an average loss of this size.

Of the 442 preferreds we follow 219 are trading under $25 which is sharply higher than the previous 162 we reported last week.

Our new Enhanced High Yield Model Portfolio , which we have just begun to build and currently contains only 2 issues, lost a  bit of value which is no surprise as this portfolio will contain many perpetual preferreds.  While both high yield and fixed to floating rate preferreds will fall less than low and mid coupon issues they will still fall when interest rates rise.  Our goal for the week is to get 2 more issues purchased for the model.

The week is a fairly quiet economic announcement week with the biggest events likely to be the 6 different speeches the various FED governors will be giving.  There have been times when these speeches move markets more than important data.

Our market expectations for next week (which may be wildly wrong) is that both interest rates and equity prices will stabilize starting mid day Monday.  The balance of the week will be some give and take (up and down gyrations), with income securities gaining a bit as investors calm down a bit and become rational (it is our opinion that less seasoned income investors tend to buy high and sell low during these drops–then they refuse to get back in until prices rise when they buy).

Our watch list for the week focuses on issues that may fit well to the Enhanced High Yield Portfolio.  This would included high yield fixed rate or fixed to floating rate preferreds or baby bonds.  Additionally some of the retail related REITs are close to having current yields that are attractive.  This would include KIMCO (NYSE:KIM) which sports a 7.53% current yield or Whitestone REIT (NYSE:WSR) which is a smaller REIT which now has a 9% current yield.


The Wild Ride Continues

The DJIA is off 630 points (2 pm CST) as I write and maybe will tumble further into the close. Lots of nervous Nellies–obviously they have short memories or are youngsters. We are just a few percent off all time highs–big deal to some we are off 2.4%.

We just checked our personal portfolios and we are off 1/4%–primarily because of our concentration in term preferreds and short maturity baby bonds. One of our recent purchases, Spark preferred (SPKEP) is off 1% today–we have little concern over a 25 cent loss in a security which will pay us a hefty dividend.

It is our hope–and just that, that we will get a bit of a respite in interest rates on Monday. Typically when interest rates move they stop and regroup before moving higher/lower and a break would be welcome

As a side note the FED cut loose of $20 billion in assets in the last week–the biggest runoff yet in the quantitative tightening. Obviously removing pretty big bucks from the demand side of the marketplace can have a noticeable affect.

Fed Balance Sheet Trends can be seen here. You have to change the time frame to a shorter time frame to see the big drop in assets.

Time to Watch – Not Buy or Sell

With the employment number out and interest rates moving higher (because of the 2.9% year over year wage increase) by 4 basis points we may have another day of setbacks in the income issues market.

While it is very possible that most preferreds and baby bonds may fall today we think that bigger bargains may be yet to come in the next 5 months.  If you are a purely income investor not so worried about you capital maybe you want to nibble a bit.

If you are buying now we would stick to high yield (mortgage REITs?), fixed-to-floating, short maturity baby bonds and term preferreds.

For holders of the high quality, low coupon perpetual issues DON’T panic.  If you own these kind of issues we assume you are in it for the safe income stream and this will continue, but studying your brokerage statement multiple times a day is a good way to do HASTY things like selling.  DON’T become a buy high, sell low income investor–although honestly at least 1/2 of individuals are this type of investor.

Interest Rates Popping Sending Income Issues Dropping

The end of the trading day saw the 10 year treasury pop up to 2.77% which sent quality income issues lower,which had a strange jump in price yesterday back down. When the quality issues popped up yesterday after a big tumble the previous day we thought it seemed strange–guess investors got so excited with the couple extra nickels they could garner with higher current yields they couldn’t resist moving prices higher.

Worse than the closing treasury prices are the overnight prices in Asia as the 10 year hit 2.80%. When we wrote the Monday Morning Kickoff this week we mentioned that traders were looking for a move to 2.80% if prices breached 2.68/2.69%, but we were thinking this would take a little longer than 4 days. With the employment report first thing tomorrow we will see how markets react.

At this moment we would pause any buying until we see how things shake out in the next day or two. Short duration baby bonds and term preferreds continue to trade reasonably strong and can be bought. Perpetuals, even high yield, should be paused–why buy today when you may get them 50 cents cheaper next week?

We are kind of drooling over some REITs-in particular KIMCO (NYSE:KIM) which is a investment grade shopping center REIT. I reviewed their financials from the 3rd quarter and they were fine and they should be releasing 4th quarter results soon (corrected–to announce 2/15) and I will be anxious to see them. We expect they will be as expected and maybe that will reverse the share slide. Shares closed today at $15.36 with a current yield of 7.29%. We will watch–who wants to catch this falling knife?

Model Portfolio Being Built

We have always included model portfolios on our websites to be used generally as a teaching tool and we have begun to build these models.

It is likely we will put together quite a number of models over the coming months as we would to model high yields, super safe, and enhanced (fixed income with additional issues such as REITs added in for a potential extra boost) models.

We have started the high yield model thus far and have made 2 purchases in the portfolio (disclosure — we personally have recently purchased Spark Energy preferreds).

The High Yield Model can be found here.

We will be writing in more detail on our investment choices in the very near future.